Report on Failed Radical Change Through Conceptual Framework: Argument Answer
Audit and Assurance
The conceptual framework of the Financial Accounting Standards Board (FASB) is intended to serve the interest of the public through the setting of goals along with qualitative characteristics. This framework provides guidance for the selection of an economic phenomenon. It’s identification and evaluation in the financial reporting assists in providing a means for communication of information to the interested stakeholders. This framework guides the Board in evaluating sound accounting principles (FASB, n.d.). Australian Accounting Standards Board (AASB) is a government agency of Australia which develops and maintains the financial reporting standards implemented on the public and private entities of the economy of the country (Australian Accounting Standards Board, n.d.).
Definition and Recognition of Elements of Financial Statements
Statement of Accounting Concepts (SAC) 4 represents the ‘Definition and Recognition of Elements of Financial Statements‘. It is prepared by the Public Sector Accounting Standards Board of the Australian Accounting Research Foundation along with AASB. Its purpose is to define the various elements of financial statements such as assets, liabilities, revenues, expenses and equity besides specifying the criteria for recognizing them in the financial statements (Australian Accounting Standards Board, n.d.).
Brief discussion on SAC4
However, it has been considered a crucial element to make sure that the firms do not hide any important information from investors, lenders, owners and regulators. But it has been perceived that lobbying still exists and SAC4 is misused for controlling the accounting standard settings. As a result, financial scams lead to losing investor’s confidence in the companies.
So, this essay is addressed to the chairpersons of the Financial Reporting Council and Australian Accounting Standards. It explains the role of SAC 4 in the elimination of fraud from the companies. It also evaluates how far SAC 4 has been successful in preventing the public sector from manipulating the accounting standards. SAC 4 defines the various elements of financial statements namely assets, liabilities, revenue, equity and expenses. It specifies their criteria for recognizing them in the financial statements. Assets can be explained as the economic benefits arising in the future which are controlled by the organization due to the past transactions or events. The criteria for recognizing the assets are that the economic benefits incorporated in the assets should occur in the future. The assets should also possess a value which can be physically measured. Liabilities pertain to the sacrifices of economic benefits arising in the future which an entity is obliged to make to the other entity due to the past events or transactions.
Discussion over criteria for recognizing the liabilities, assets and recognizing revenue for economic benefit.
The criteria for recognizing the liabilities is that the sacrifice of economic benefits would be required in the future. The amount of liability can be measured physically. Equity can be defined as the residual interest in the assets after deducting the liabilities of an organization (Crowther, 2018).
Revenues can be defined as the inflows or savings in outflows which give rise to future economic benefits. These may be in the form of an increase in assets or decrease in liabilities except than those pertaining to the contributions made by the owners resulting in enhancements in equity during the reporting period.
The criteria for recognizing revenues are that there is an occurrence of inflow or savings in the outflow which would result in economic benefits in the future. These benefits are physically measurable. The last element explained in the statement is an expense. These can be termed as loss of future economic benefits in the form of an increase in the liabilities or reduction of assets. However, those expenses related to distributions to the owners, resulting in a decrease in equity should be excluded from the definition (Bay, Catasús & Johed,2014). The criteria for recognizing the expenses in the statement is that it is possible that the consumption or loss of future economic benefits would result in a reduction of assets or increase in the liability. The loss of future economic benefits can be measured physically. In these statements, the economic benefits arising in the future can be differentiated from their source which is a specific object or right. It refers to the benefits and not to their source as the absence of the economic benefits arising in the future would not be a benefit for the entity and hence could not be considered as an asset. For example, a machine would normally be an asset but in case if it becomes obsolete or has no value then it would not be qualified as an asset (Gray & Debreceny, 2014).
SAC 4 comprises of obligations
Another point here is that the obligations which are legally enforceable are liabilities. The concept of liabilities as stated by SAC 4 comprises of obligations which are imposed by notions of fairness and equity or usual business practices along with those arising from legally enforceable contracts or torts. But in practical life, difficulties may exist in determining if it is an equitable or constructive obligation. It is generally assumed that the users of financial report are well versed with the knowledge of these obligations.They can evaluate and make decisions regarding the allocation of scarce resources.
This may give birth to manipulations and suspicions in the preparations of financial statements. There are instances where some of the equally proportionately unperformed agreements give rise to liabilities and assets (Dichev, 2017). It may lead to confusion amongst the stakeholders and many can use it for manipulating the financial statements.Some of the entities would gain control over the economic benefits and incur current obligations for sacrificing economic benefits arising in the future.
In the lease agreements, it is accepted that the definitions of assets and liabilities along with their recognition criteria are satisfied. But in the case of many other agreements, there is always an uncertainty related to the satisfaction of recognition criteria (Zhang & Andrew, 2014). The users also face the difficulty to measure the assets and liabilities arising due to these agreements. If these assets and liabilities are recognized on the basis of relevant criteria, then it would represent a fundamental change to the current reporting procedures followed in Australia and in an overseas jurisdiction.
So, in this way, the manipulation of the elements of the financial statements can result in falsification of balance sheets, cash flow statements and income statements in order to fool the stakeholders. The management can manipulate the statements for its personal gains( Minnis & Sutherland, 2017). If their incentive is dependent upon the revenue earned by their company, then they will inflate the revenues in the income statements. On the other hand, if the performance of the company is poor, then the statements shall be falsified by the owners to keep the shareholders happy.
They even manipulate the statements so that the company looks healthier in front of investors. They do this by inflating the values of assets and revenue or by deflating the figures of liabilities and expenses. It is also contended that the statements can place a bias for the financial position of the company as the revenues and expenses are defined in terms of fluctuations in assets and liabilities. It also states the prerequisite regarding the necessity of an item to satisfy the definition of assets, liabilities and equity (Henderson et al., 2015).
As per SAC4, the value of the elements of financial statements
As per SAC4, the value of the elements of financial statements should preclude some of the deferment amounts which have been made previously so that they can report the impacts of certain events in the operating statements over various reporting periods. Yet SAC 4 has been used for committing financial statements fraud but the boards are of the view that for accomplishing the objectives of general purpose financial reporting, the statements of financial reporting and operating statements should provide accurate information which can be depended upon by the stakeholders. So, SAC 4 equally emphasizes on each of these financial statements. It has defined each of the elements of financial statements in the context of economic benefits or sacrifices arising in the future. Hence, the revenues and expenses are defined in the context of fluctuations in assets and liabilities (Weygandt, Kimmel & Kieso, 2015).
In this case, the existence of liabilities and assets should be confirmed at the point of time. But this is not the case for revenues and expenses. The explanation of revenues and expenses in terms of variations in assets and liabilities provides the framework for reporting the figures as per their economic substance. It limits the scope for intentional and biased reporting of expenses and revenues. So defining the revenues and expenses does not denote that the fluctuations in assets and liabilities necessarily create an impact on the reported results (Macve, 2015).
It depends on the nature of the measurement model adopted that the fluctuations in the value of assets might be considered as a direct adjustment to the equity without affecting the result. So, SAC 4 employs various mechanisms for displaying the expenses and revenues in the operating statements so that their usefulness can be maximized for assessing the performance of the company. The utility of the financial report for demonstrating the economic substance of the operations of the entity is not only dependent upon the basis on which the components are identified and explained but also on the basis of measurement implied on them (Patelli & Pedrini, 2015). It also depends upon the manner of their presentation in the financial report. Through SAC 4, the elements of the financial statements have been structured in such a way which allows a range of current and potential approaches towards the measurement and demonstration of financial data. But on the other hand, its scope does not extend to all those aspects which the statement does not resolve. They pertain to reporting of the commercial reality and economic substance of the operations of the entity.
Evaluates the assets and liabilities by experts of SAC4
Some of the experts in the field argue that SAC4 evaluates the assets and liabilities at the present market value with fluctuations in those values which are included in the reported results. It is, therefore, the Statement emphasizes on the information about the fiscal position which can be contrary to the information about the performance of the company (Amiram, Bozanic & Rouen, 2015). Additionally, comments were also made regarding the definition of liabilities. It was said that the Statement would have evaluated the required liabilities arising due to unearned revenues in such a way that the profits are reported prior to the performance by the company.
However, it has been cleared the Statement is compatible with the different modes of measurement such as historical cost or current value accounting. As per FASB, the general criteria for recognition in each of the components should be symmetrical. They have not adopted a conservative basis in this regard. The conservative criteria should not be confused with the exercise of prudence while managing the uncertainties in the procedure for recognition and evaluation (Australian Accounting Standards Board, 2016). The Board supports the prudential exercise and assures that as per SAC4, proper evidence is obtained for establishing if the item is probable and it is ensured that it is measured consistently. Moreover, the application of the definition and recognition criteria can give rise to the necessity of resolving the measurement issues in the preparation of fiscal reports. In order to report the performance of an entity, the revenues, losses, gains and expenses should be separately reported in the profit or loss or in the other statements. The definitions as mentioned in SAC4 should reflect this variation.
It should not merely address the display level of the conceptual framework as explaining the revenues and expenses to include gains and losses might encourage the demonstration of revenues and expenses without being structured to assist the assessment of the performance of the entity (Frias‐Aceituno, Rodríguez‐Ariza & Garcia‐Sánchez, 2014).
Hence to conclude, it can be said that though there are some shortcomings in the conceptual framework, it can help in legitimizing the current accounting practices, maintain the existing socio-economic status and prevent the public sector from manipulating the setting of accounting standards. The concepts of SAC 4 should be followed in letter and spirit. Furthermore, SAC 4 is also compatible with the accosting concepts set out in Framework for the Preparation and Presentation of Financial Statements issued by the International Accounting Standards Committee (IASC). This makes it a more reliable and accurate model for evaluating the financial performance of the entities.